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Austro-Wicksellian Theory of the Business Cycle: An Informed View

April 13, 2010

by Mario Rizzo

There has been recent discussion in the blogosphere of the so-called Austrian Business Cycle Theory (ABCT). (We must not forget to give the Swedish economist Knut Wicksell credit as well.) Some of it is interesting (mostly because of the comments) but much of it is ill-informed since the bloggers don’t like to read scholarly Austrian work. For a good blog post with references to what others have been saying, see Pete Boettke’s discussion at Coordination Problem.

The first thing to keep in mind is that while this theory embodies “Austrian” characteristics it is not an official Austrian theory. What do I mean by that? Eminent Austrian economists have made important criticisms of the bare-bones theory. For example, Israel Kirzner has criticized the theory for not taking entrepreneurship seriously. Where are the alert entrepreneurs either in the boom phase or the recession phase? There are profits to be made from avoiding mistakes. Another eminent Austrian economist, Ludwig M. Lachmann — one of the main contributors of the development of the idea of capital heterogeneity which is an important constituent part of the cycle theory — criticized the ABCT for assuming that agents simply expand their investment whenever interest rates fall. And Ludwig von Mises agreed that we need to take account of what the agents expect about the future course of interest rates.

Second, the ABCT is only a partial theory of the cycle — specifically of the upper turning point. We should also not expect it to explain all business cycles — just those which are generated by excessive credit expansion to businesses.

Third, the ABCT is a work-in-progress. I agree with Tyler Cowen that we can build on it. On the other hand, I am not so critical of its present state to believe that it does not capture important features of the current cycle unseen through Keynesian glasses.

As the reader will see below there are certain “Keynesian” features in the boom and in the recession. But the key difference is that aggregate movements are constituted by relative (sectoral) movements or distortions. Thus, the boom becaomes unsustainable due to real factors (resource constraints).

(I should add that the idea that aggregate (demand) movements are “really” relative movements — a mismatch between sustainable supply and demand in various sectors or a failure of coordination goes back as far as J.B. Say. This is how informed economists understood Say’s Law long before Keynes wrote. So calling this aggregate aspect a “Keynesian” feature gives Keynes undeserved credit. See Steven Kates, On the True Meaning of Say’s Law, Eastern Economic Journal, Spring 1997.)

Keynes was completely uninterested in why the boom collapses except to talk about “animal spirits.” People lose confidence. Yes, but why? Are they simply nuts? Not in the Austro-Wicksellian view.

The conversation would be advanced quite a bit if people would read the scholarly literature.

Below I reproduce portions of my article for the New Palgrave Dictionary of Economics (on-line) called, “Austrian Economics: Recent Work.” So begin here. (For the bibliography, go either to the gated New Palgravesite or to my bepress site)

“The Austrian Business Cycle Theory (ABCT) received a major system­ization and reﬁnement in the work of Roger Garrison, culminating in his book, Time and Money: The Macroeconomics of Capital Structure (2001). The previous work in the subject was scattered in many articles by Friedrich Hayek and in the work of Ludwig von Mises. It was also very imperfectly linked to the brilliant, but underrated, work by Ludwig Lachmann, Capital and its Structure (1956). Garrison corrects these deﬁciencies and adds coherence to ABCT which had previously been unknown. In a sense, Garrison has done for ABCT what John Hicks and Alvin Hansen did for Keynes’s macroeconomics, except that the Garrison’s work is an accurate rendition of Hayek, Mises and Lachmann.

The subtitle of Garrison’s book, ‘The Macroeconomics of Capital Structure’, expresses the important claim that Austrian macroeconomics cannot adequately be appreciated without understanding that ‘investment’ is not a homogeneous decision. This insight is developed at length by Peter Lewin in Capital in Disequilibrium: The Role of Capital in a Changing World (1999), the most important work in Austrian capital theory in many decades (see also Endres and Harper, 2008). The ABCT focuses on the inappropri­ateness of the capital structure (malinvestment) generated by artiﬁcially low real interest rates (that is, interest rates that are lower than the real supply of savings would allow). Thus, the term over-investment is, by itself, a misleading characterization of the ABCT process. While excessively low interest rates do increase the level of investment relative to its previous position, they do so in a biased way – those stages of production further from consumption are aﬀected to a greater extent.

However, as Garrison’s recent work (2004) has shown, there are even more widespread distortions in the production structure generated by artiﬁcially low interest rates. These include initial ‘overconsumption’ as the result of reduced savings and of increased incomes on the part of factors of production. Increased investment in close temporal proximity to the overconsumption is labeled the ‘derived demand eﬀect’. This is in addition to the ‘discount eﬀect’, described above, which increases the proﬁtability of new investment distant from consumption. These two contrary eﬀects come at the expense of intermediate stages of production as well as reduced maintenance of existing capital at all stages. They may even result from the utilization of unused resources during periods of less than full employment. These eﬀects show that the ABCT is a type of ‘coordinationist macro­economics’ insofar as it describes the discoordination of various sectors of the economy, and is not simply a micro choice-theoretic approach to macroeconomics (Wagner, 2005).

Accordingly, in this Austrian view recessions are characterized not simply by low levels of aggregate economic activity but also by the misdirection of resources caused by previous boom-induced malinvestments. These systema­tic sectoral imbalances – too much investment in interest-sensitive areas of economic activity – must be corrected as recovery proceeds.

The Austrian theory, however, is not a complete theory of the business cycle. It accounts mainly for the process leading to and including the cycle’s upper turning point. It is a theory of the crisis. How long the resulting recession lasts is not predicted by the theory or even, strictly speaking, by the degree to which resources were misallocated. The length of the recession will depend, for example, on those factors aﬀecting the mobility of resources.

None of this implies that Hayek, Garrison or Horwitz are insensitive to the problems that would be induced by an aggregate increase in the demand to hold money (a fall in income velocity), which can accompany recessions. This ‘secondary deﬂation’ should be avoided by a concomitant increase in the supply of money by the relevant monetary institutions. Horwitz (2000) is the ﬁrst to integrate Austrian macroeconomics with monetary disequilibrium theory to analyse deﬂationary processes. Nevertheless, recessions are not primarily deﬂationary phenomena (or at least need not be), but occasions for correction of the misdirection of resources.”

—

“An important variant of the ABCT in Risk and Business Cycles: New and Old Austrian Perspectives (1998), developed by Tyler Cowen, focuses on the integration of business cycle theory with developments in modern ﬁnance. The main sense in which this can be called a variant of ABCT is that changes in the riskiness of investment decisions are linked to the ‘old Austrian’ concern with the degree of futurity or roundaboutness in investments. For example, in Cowen’s analysis, an increase in the acceptable level of risk will encourage undertaking more longer-term investments (as well as, of course, investments of any given length with more uncertain yields). These can be both investments in durable capital goods (that is, investments with a continuous ﬂow of payoﬀs over a long period of time) and investments with a long period of gestation before the ultimate output is produced. Cowen associates less risky (‘safe’) investments with consumption and shorter-term investments.

Cowen’s analysis is more general than the traditional ABCT because it allows many factors besides a fall in real interest rates to generate a lengthening of the capital structure. These include exogenous risk-preference shifts, increases in savings, easing ﬁnancial constraints, and reductions in uncertainty (so as to reduce ‘waiting’ for acceptable investment opportu­nities). Any of these changes can generate an increase in the riskiness of investment. None of these changes must necessarily cause a cyclical boom and bust, but they might do so.”

47 Responses to “Austro-Wicksellian Theory of the Business Cycle: An Informed View”

If this is what is is left of Austrian macro than everybody is Austrian right? And nobody is Austrian, too! You say that Austrians highlight the heterogeneity of investment? True, but it is I. Fisher (and later Hirshleifer) who came up with the proper investment theory (investment opportunities and the impact of interest on the RELATIVE rentability of such opportunities). You say Austrian theory is about coordination problems. That’s true but where is then the difference to the neoclassical mainstream? A two-sector model (investment and consumption) is bread-and-butter of standard theory. Just add some distributional effect and your model predicts ‘malinvestment’ and ‘non-neutrality’. Further, Garrison corrects nothing. Indeed, his book is overvalued within Austrian circles. It is good for introducing undergrads to Austrian ideas but what kind of problems inherent in Austrian capital theory is really solved by this book? Austrians don’t like to recognize that capital theory is dead for one reason: general equilibrium theorist like Bliss showed that it is redundant. All you want to say about the ‘capital structure’ you can discuss in Walrasian settings. Last but not least: you say that people should read the scholarly literature. Well, I read all this nasty ABCT stuff and I find your comment on Mises especially worrisome. You say Mises acknowledged the importance of expectations. Well, in the same paper he writes: “In the thirty-one years which have passed since the first edition of my Theory of Money and Credit was published no tenable argument has been raised against the validity of what is commonly called the ‘Austrian’ theory of the credit cycle.” This is in 1943! This is sooo Mises. Expectations or whatever challenge never impacted his thinking on ABCT. And this is true for most modern Austrians, too: you are all more open to tools which make the core prediction of the ABCT more acceptable. the core predication, however, remains the main problem of this theory: money-induced traverses by necessity reverses. There is still no evidence for that, neither analytical, nor empirical.

You may be informed in your criticisms, that is good. But yours is the material for journal debate. I just want people to get up to speed, as it were. And begin the discussion from a high level. As I have said many times, I do not consider my professional field macroeconomics or monetary theory. I am happy to engage in scholarly debates about law-and-economics, ethics-and-economics, economic paternalism and such things in the appropriate forums. My task here on this blog is to raise questions and issues that are ignored in the popular economic press.

Oh, I didn’t know. Given that you wrote 10 out of 20 posts on the ABCT as a category of this blog, I simply presumed that you are willing to discuss such matters here. My bad. BTW, if my comment is “material for journal debate” so is your post. Isn’t it?

A note that we must be careful were simply aren’t looking for stawmen no-one ever assume, for the sake of proving how “clever” one is as a “brilliant” critic. Such bogus “cleverness” seems to dominate the secondary literature — and the blogosphere.

Mario writes.

“Another eminent Austrian economist, Ludwig M. Lachmann — one of the main contributors of the development of the idea of capital heterogeneity which is an important constituent part of the cycle theory — criticized the ABCT for assuming that agents simply expand their investment whenever interest rates fall. And Ludwig von Mises agreed that we need to take account of what the agents expect about the future course of interest rates.”

even though you are right in saying that many concerns of the Austrian school have been taken into account in modern models, you are mistaken in saying that the Austrian school’s explanation is irrelevant today.

Indeed modern theory can show how an economy reacts to a positive or negative shock for instance on interest rates. However, there is no pattern that allows the cycle to emerge endogenously. If there is a shock, the system of equations will lead to convergence to the equilibrium path. But a cycle goes both ways: up and down.

In an Austrian model the boom turns into a bust endogenously, causing below equilibrium-outcomes for a while. If the entrepreneur is included in the model like in Lachmann’s or Cowen’s explanations, there is no need for external forces at all.

What is bizarre is how this invented strawman “ABTC” theory has become completely disconnected from Hayek’s rich cycle theory work.

But maybe this is not so surprising — people need bogus strawmen to dismiss, as an excuse for avoiding thinking and study.

What we need is to force people to engage the real stuff — like Hayek’s actual work or Roger Garrison’s actual work or Gerald O’Driscoll’s actual work. This would either change their understanding — or expose their ignorance, incompetence, and dishonesty.

“You say Austrian theory is about coordination problems. That’s true but where is then the difference to the neoclassical mainstream?”

You are kidding us in saying you have no inkling, none at all?

Really?

“A two-sector model (investment and consumption) is bread-and-butter of standard theory. Just add some distributional effect and your model predicts ‘malinvestment’ and ‘non-neutrality’.”

Got a cite?

“Further, Garrison corrects nothing. Indeed, his book is overvalued within Austrian circles. It is good for introducing undergrads to Austrian ideas but what kind of problems inherent in Austrian capital theory is really solved by this book?”

What’s the problem? Name it. Is it a real problem, or a problem with a particular explanatory strategy rejected by Hayek and others?

“Austrians don’t like to recognize that capital theory is dead for one reason: general equilibrium theorist like Bliss showed that it is redundant. All you want to say about the ‘capital structure’ you can discuss in Walrasian settings.”

Again, are you kidding us. And, have a cite which makes your case?

“Last but not least: you say that people should read the scholarly literature. Well, I read all this nasty ABCT stuff and I find your comment on Mises especially worrisome. You say Mises acknowledged the importance of expectations. Well, in the same paper he writes: “In the thirty-one years which have passed since the first edition of my Theory of Money and Credit was published no tenable argument has been raised against the validity of what is commonly called the ‘Austrian’ theory of the credit cycle.” This is in 1943! This is sooo Mises. Expectations or whatever challenge never impacted his thinking on ABCT.”

Hayek and Mises always assumed expectations and changing expectations — I’ve never seen how this is any challenge at all. The case is not made, and begs the question.

“And this is true for most modern Austrians, too: you are all more open to tools which make the core prediction of the ABCT more acceptable. the core predication, however, remains the main problem of this theory: money-induced traverses by necessity reverses.”

The alternative assumption assumes magic — nothing more and nothing less. This is Hayek and Garrison’s claim against Kaldor and Keynes — you are aware of that, right?

“There is still no evidence for that, neither analytical, nor empirical.”

Are you kidding? This would be more evidence that you haven’t read the literature.

Rizzo’s suggestion that folks engage the literature in a serious fashion stands — people are attracted to imagining and attacking cheap and erroneous “models” of their own imagination.

And note well — part of Hayek’s attack was on the whole notion that the explanatory / causal effort of economics could be captured in tractable mathematics — a reject of the whole program of modern textbook / publish or perish math economics.

amv — you argument is the equivalent of saying that Wittgenstein’s attack upon and alternative to the Frege / Russell “analytic” program is fully capture by work done by those continuing in this Frege / Russell tradition. Which any Wittgensteinian would immediately recognize as a big red “not getting” it flag.

Hayek already made these links (in a simply way) in his 1928 and 1960, as a careful reading reveals.

“The main sense in which [Cowen’s work] can be called a variant of ABCT is that changes in the riskiness of investment decisions are linked to the ‘old Austrian’ concern with the degree of futurity or roundaboutness in investments.”

well, if I just knew the works of wittgenstein and frege and russell … I’m just an economist. I like to talk about assumptions, propositions, economic mechanisms, etc. but you are right: the ABCT I critizise is indeed a strawman version. unfortunately, it is mises’s and he is damn serious about it. hayek is a great economist … but prices and production is flawed and as far as I know he dismissed the entire ABCT approach and sides with a view close to slutzky and lutz.

That you don’t get my point is my fault. I’m serious about this. The econ-blogshpere has the unavoidable defect that highly complex problems are frequently raised but with little patience for purely theoretical contributions. See Mr. Rizzo’s reaction to my first comment. And he is right: the blogsphere is no substitute for scholarly work. But it is fun, right? Second, I always sound rougher than intended.

AMV: as far as I know, not only capital structure is redundant in general equilibrium: also institutions, money, financial markets, firms, financial structure, fiscal policy. I would say that GE (in the neoclassical version, although also NK is GE) makes all economic reality redundant.

“Second, the ABCT is only a partial theory of the cycle — specifically of the upper turning point.”

This is a statement that is often done, also by my favorite reference to ABCT, Garrison. But in my opinion it is too strong a statement.

The notion of structural unsustainability caused by credit manipulation through monetary means is the core of the theory. This make it both non-neoclassical and non-keynesian, and this puts an end to Paul Krugman’s ball (cit.). This is also the reason why there must be an upper turning point.

However, there is a variety of phenomena which happen ex post, which have been analyzed both within and outside AE, which explain the recession.

I would introduce a distinction in four classes, which are the Kronecker product of the two sets (a) economic decelerators which are embedded in AE theorizing, (b) economic accelerators which have not been analyzed in AE or are not peculiar to it, and (1) problems of aggregate demand and (2) problems which have nothing to do or cannot be countered or are made worse by aggregate demand expansion.

I would focus on the (a1) class (problems embedded in AE which cannot be solve by AD policies):

1. Banks in the recession need to reduce loans. This destroys credit and pushes the economy withing the PPF (some sort of a reversed injection effect). The first analysis I found of the topic is in Strigl’s 1937 “capital and production”. It is now known (with a much better microeconomic detail) as credit-channel view. I think this is a sufficient (albeit abstract and undetailed) reason for the crisis, and it is now called “deleveraging”. It cannot be countered by AD policies because it is an endogeneous adjustment to an unsustainable financial structure.

2. If production has exceeded the PPF for some time, something must have been forgotten in the process. This may be renewal of all fixed capital, of money illusion by part of workers increasing their supply of labor, or a shift from long-run efficient to short-run efficient (but stationarily inefficient) production processes. Whatever the dynamics (still an open problem), this is equivalent to (1a), but with a standard Austrian focus on production rather than financial unsustainability.

I wouldn’t say this is not a theory of a recession. I just say it is not a theory of the great depression, because there is nothing here that should require more than several quarters of panic adjustment.

The problem is that almost all of economic theory after 1929 appears to be the study of a single outlier, the great depression, whose theoretical importance (being just an outlier) is in my opinion overstated. Ohanian 2009 cites Rothbard 1963 which cited Phillips 1937, all saying “if you don’t cut wages with falling prices, you don’t get profits and destroy capital”, which doesn’t require much more than introductory microeconomics. This said, in my opinion, there isn’t much left to explain, and surely little need for new explanatory theories. (this is an overstatement, but not as enormous as it may appear :-D).

at pietro: capital structure is redundant because the allocation of endowments and incomes is the more general way of saying the same thing. institutions are inessential only at zero transaction costs. nobody forces you to define a neat convex environment without externalities. for money in GE check Starr and especially ostroy. guys, I do not mean that textbook neoclassical theory is superior to Austrian theory. I just think that advanced neoclassical theory (e.g. mechanism design) is very much aware of the problems of Walrasian theory and produces interesting insights. I started as an Austrian, but I realized that Austrians like to repeat the same stuff over and over again. and see: nobody really counters with arguments …

As Hayek understood even when he wrote it — it included problematic makeshift shortcuts.

It turns out that insight into these problems were one of the major economic findings of the last 100 years — the problem of the mathematical intractability of capital theory in any form worthy of the name.

There are is a round-robin of letters between leading economists on this topic in the Hayek archive, and the significance of Hayek’s efforts in the development of what came later is little known (e.g. Hayek’s work on production/capital/macroeconomics inspired Harrod’s original version of “growth theory”).

The logical / mathematical intractability of any capital theory worth wasting time on is at the center of Hayek’s move toward a causal / learning model of the explanatory strategy of economics, and away from a pure logic / math “modeling” strategy for providing “explanations” (which this “models” simply cannot provide — they as a matter of logic cannot include the central causal element of economic explanation, open-ended learning stands outside of math or logic .. see Kuhn, or Edelman or Popper or Hayek).

Open-ended learning in the context of changing relative prices and local conditions stands outside of any logic or math construct — as a matter of LOGIC. Mainstream neoclassicals are oblivious to this basic understanding at the heart of Hayek’s work. And the institutional incentive structure of the profession enforces this blindness — every incentive it to force pretend that everything is “statistical testing” and math constructs.

The mainstream at its core is pathological, and this is the deepest division between the Hayek program and the fake science program of the mainstream.

Rivalrous, imperfect and open-ended learning in the context of changing relative and local conditions is the causal explanation which solves the coordination problem of the great society — by assumption and institutional demand the “mainstream” is completely blind to THE central causal explanatory mechanism in the economic domain.

AMV wrote:

“You say Austrian theory is about coordination problems. That’s true but where is then the difference to the neoclassical mainstream?”

Theories of economics are usually dependent on particular initial conditions being satisfied before events can be truthfully interpreted in their light.

In the case of ABCT, an over-expansion of credit induced by a central bank is one such initial condition. Since the logical implications of a theory like ABCT are unfathomable, there are always other necessary initial conditions that we are unaware of. A lot of criticism of ABCT takes the form of identifying some such initial condition, and then claiming that it is at variance with ordinary expectations (e.g. entrepreneurial anticipation of temporarily suppressed interest rates).

For me, this is not so much a criticism as an exploration of a teory (which may be mistaken for other reasons). ABCT is a theoretical construct that can only be mistaken because of some error of economic logic–so long as the necessary intitial conditions actually hold, it will tell a true story of the boom and bust. In the case that the initial conditions do not hold, ABCT is inapplicable.

People tend to confuse these matters in unhelpful ways. They talk as though the possibility (or actuality) of a particular boom and bust not following the ABCT story is a major problem for Austrian economics. Perhaps it is a problem for those who believe ABCT to apply in the given instance, but the theoretical construct of ABCT remains untouched by such “criticism.” Very much similar points can be made regarding other theories of the business cycle.

Lee, Hayek’s ABCT theory is not a construct of pure logic / math. Hayek always assumed a causal process dynamic with imperfect learners within an imperfect price system. The math constructs where uses to hopefully shed insight on the this real world. Unfortunately, often they don’t.

Yes, entrpreneurs may understand that the interest rate will rise in the future and account for that. However, it is by no means certain. I think that it is very unlikely that all entrepreneurs can do this. And, if a large enough section of them can’t fathom out the future increase in interest rates then there will be ABCT.

I don’t think that expectations can plausibly allow entrepreneurs to see through the Cantillon effect.

Okay, perhaps the over-expansion of credit does not have to be induced by a central bank. Usually that is an element of ABTC, but it needn’t be–I don’t want to quibble about definitions. In any case, it was merely an illustrative example of a general principle.

A lot of criticism of ABTC is an exploration of its necessary initial conditions, because if some necessary condition rarely holds true in actuality, then ABTC may not be applicable to any particular boom and bust–regardless of its logical coherence. To me this is not a criticism of ABTC per se, but of it being used to interpret (i.e. tell a story about) a particular boom and bust episode.

A very similar failure to make this distinction is common when addressing alternative business cycle theories.

Lee, the bottom line is that _any_ cycle phenomena will involve distortions across the time structure of production (and consumption as well) and will involve at once shifts and distortions in nearly all relative price relations, nearly all production inputs, the whole world of finance & leverage, and output valuations as well.

It’s hard to see how much anything out there besides Hayekian macro truly engages this central fact of economic science — because a pure math construct logically can’t handle this mathematically intractable real world.

I want to return to Mario’s original post, which is an important contribution. Wicksell acknowledged the importance of the Austrians and the Austrians acknowledged the importance of Wicksell.

Neoclassical economics in Europe in the early 20th century was Austrian. The Austrian School also influenced the LSE tradition. That is why Hayek was invited to LSE.

Mises and Hayek were interested in developing a theory to explain acknowledged facts. The core issue was the disproportional effects on the “constructional” industry (Schumpeter’s term) over the business cycle.

Expectations were central to Hayek’s theory of economic fluctuations. I’ve never understood Kirzner’s issue with Hayek. Hayek didn’t use the term “entrepreneur” all that often, but his theory hinged on the reactions of entrepreneurs to price signals.

Hayek and the Swedes were way ahead of Keynes. How can “animal spirits” be taken seriously as an expectations theory?

Mario specified what he means by ABCT. But many commentators on Austrian blogs do not (on both sides). To be productive, conversations need to be more specific than “ABCT.”

I agree that commentators should specify what they mean with ABCT. But can you please give me a hint where I can find the role of expectations (in contrast to pure adaption to price signals) in Hayek’s version of the ABCT? In one of the articles in Profits, Interest, and Investment hayek discusses the role of expectations (I don’t have it here at my office). There, he closes the book on his ABCT and turns to the ideas of friedrich lutz (and thus slutzky). It is quite modern: shock driven stochastic processes explain the cycle and the role of money is less important (or less obvious) than in his traditional outline of the ABCT. Last but not least: Wicksell was always highly critical of the ABCT! In his review of Mises’s Theorie des Geldes und der Umlaufsmittel (in 1914), he argued that monetary expansion due to the interest rate spread cannot account for switches in technique (for more roundabout processes), at least given Böhm’s framework. He argued that the scale of firms adjusts, but that the choice of technique remains unaltered.

You say that no explanation is given for how long the bust will last — but won’t that depend greatly on how governments, investors, banks, etc. respond to the bust? Hoover’s and FDR’s response to the depression turned it into the Great Depression. Wilson’s reaction to his, made it almost forgotten.

“Lee, the bottom line is that _any_ cycle phenomena will involve distortions across the time structure of production (and consumption as well) and will involve at once shifts and distortions in nearly all relative price relations, nearly all production inputs, the whole world of finance & leverage, and output valuations as well.” – Greg

Perhaps this is true of the actual cycles that have or will occur, but it does not follow an alternatives cycle–where the structure of production and relative prices are not distorted–is theoretically impossible. As a matter of economic theory, I believe such cycles are possible, and I believe that is is likely that such cycles have actually occurred.

“an alternatives cycle–where the structure of production and relative prices are not distorted–is theoretically impossible. As a matter of economic theory, I believe such cycles are possible, and I believe that is is likely that such cycles have actually occurred.”

“Price Expectations, Monetary Disturbances and Malinvestments” is one of Hayek’s most important essays and is an early one (1933) in the evolution of his thought on the issue. It is in that essay that he presented the thesis later developed in “Economics and Knowledge.”

Hayek’s theory is about the dis-coordination of plans. That is another way of saying unfulfilled expectations. Economics as a Coordination Problem focuses on the unity of Hayek’s thought and, specifically, the relationship between his monetary theory of cycles and his work on prices and coordination. See esp. pp. 102-08 of that volume.

There is no such thing as “pure adaptation to price signals,” except in a one-period exercise in a static model.

Wicksell and Mises debated within a common theoretical framework. Mises was crticial of B-B’s presentation of capital theory.

People have looked to empirical evidence to see instantiations of Hayekian macro in the data .. what we need is someone to look empirically at Wicksell’s claim. (Much of the data seems to confirm Hayek, in the papers I’ve looked at, but have not examined in detail).

amv writes:

“Wicksell was always highly critical of the ABCT! In his review of Mises’s Theorie des Geldes und der Umlaufsmittel (in 1914), he argued that monetary expansion due to the interest rate spread cannot account for switches in technique (for more roundabout processes), at least given Böhm’s framework. He argued that the scale of firms adjusts, but that the choice of technique remains unaltered.”

I’m reading “economics as a coordination problem” now after the first time I read it many months ago. I didn’t grasp the importance of many aspects of the book at that time (as if it were a long period), and now I’m enjoying it much more. Prof O’Driscoll’s frequent references to coordination here and on Coordination Problem is now much clearer to me.

AMV, you obviously have read a lot on this, but let me dispute one of your original claims: I don’t think you can illustrate Misesian malinvestment in a two-good neoclassical growth model.

In such a model, if the agent saves too much, all that happens is that the capital stock grows above the optimal rate. So the agent’s utility is less than it otherwise would have been, because the sacrifice in current consumption is not offset by the augmentation in future (discounted) consumption.

But after the mistake in having too much saving, there is no “bust.” It’s a one-shot mistake. The capital structure isn’t “unsustainable” because of the mistake back in period t(35).

In fact, without a fairly complex capital structure involving several stages of varying “distance” from final consumption, it’s hard to even explain what “malinvestment” is.